Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2011

OR

o

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For transition period from to

Commission File Number: 000-19756

PDL BIOPHARMA, INC.

(Exact name of registrant as specified in its charter)

Delaware

94-3023969

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification Number)

932 Southwood Boulevard

Incline Village, Nevada 89451

(Address of principal executive offices and Zip Code)

(775) 832-8500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
x
No
o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes
x
No
o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
x

Accelerated filer
o

Non-accelerated filer
o

Smaller reporting company
o

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes
o
No
x

As of November 1, 2011, there were 139,834,559 shares of the Registrant’s Common Stock outstanding.

We own or have rights to certain trademarks, trade names, copyrights and other intellectual property used in our business, including PDL BioPharma and the PDL logo, each of which is considered a trademark. All other company names, product names, trade names and trademarks included in this Quarterly Report are trademarks, registered trademarks or trade names of their respective owners.

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments) the management of PDL BioPharma, Inc. (the Company, PDL, we, us or our) believes are necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of results expected for the full fiscal year or for any subsequent interim period.

The accompanying Condensed Consolidated Financial Statements and related financial information should be read in conjunction with the audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2010, included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission. The Condensed Consolidated Balance Sheet at December 31, 2010, has been derived from the audited Consolidated Financial Statements at that date.

Principles of Consolidation

The Consolidated Financial Statements include the accounts of PDL and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

Customer Concentration

Revenues from our licensees’ products, which individually accounted for 10% or more of our total royalty revenues, were:

Three Months Ended

Nine Months Ended

September 30,

September 30,

Licensee

Product Name

2011

2010

2011

2010

Genentech, Inc. (Genentech)

Avastin
®

29

%

35

%

32

%

34

%

Herceptin
®

38

%

32

%

36

%

33

%

Lucentis
®

15

%

13

%

16

%

14

%

Elan Corporation, Plc (Elan)

Tysabri
®

14

%

10

%

12

%

10

%

Revenue Recognition

Under most of our patent license agreements, we receive royalty payments based upon our licensees’ net sales of covered products. Generally, under these agreements we receive royalty reports and payments from our licensees approximately one quarter in arrears, that is, generally in the second month of the quarter after the licensee has sold the royalty bearing product or products. We recognize royalty revenues when we can reliably estimate such amounts and collectability is reasonably assured. As such, we generally recognize royalty revenues in the quarter reported to us by our licensees, that is, royalty revenues are generally recognized one quarter following the quarter in which sales by our licensees occurred. Under this accounting policy, the royalty revenues we report are not based upon our estimates and are typically reported in the same period in which we receive payment from our licensees.

We may also receive minimal annual maintenance fees from licensees of our Queen et al. patents prior to patent expiry as well as periodic milestone payments. We have no performance obligations with respect to such fees. Maintenance fees are recognized as they are due and when payment is reasonably assured. Total annual milestone payments in each of the last several years have been less than 1% of total revenue.

Foreign Currency Hedging

We hedge certain Eurodollar currency exposures related to our licensees’ product sales with Eurodollar forward contracts and Eurodollar option contracts (collectively, Eurodollar contracts). In general, these contracts are intended to offset the underlying Eurodollar market risk in our royalty revenues. We do not enter into speculative foreign currency transactions. We have designated the Eurodollar contracts as cash flow hedges. At the inception of the hedging relationship and on a quarterly basis, we assess hedge effectiveness.

The fair value of the Eurodollar contracts is estimated using pricing models with readily observable inputs from actively quoted markets. The aggregate unrealized gain or loss on our foreign currency exchange contracts, net of estimated taxes, on the effective portion of the hedge is recorded in stockholders’ deficit as accumulated other comprehensive income (loss). Gains or losses on cash flow hedges are recognized as royalty revenue in the same period that the hedged transaction, royalty revenue, impacts earnings. The hedge effectiveness is dependent upon the amounts of future royalties. If future royalties based on Eurodollar are lower than forecasted, the amount of ineffectiveness would be reported in our Condensed Consolidated Statements of Income.

Recently Issued Accounting Pronouncements

The Financial Accounting Standards Board recently issued accounting standard update (ASU) 2011-05, eliminating the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The update requires presentation for items of net income and other comprehensive income either in one continuous statement or in two separate, but consecutive, statements. This ASU also includes a new requirement to show reclassification adjustments from other comprehensive income to net income on the face of the statement. This guidance is required for our first quarter of 2012 with retrospective application also required. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.

2. Net Income per Share

We compute net income per basic share using the weighted-average number of shares of common stock outstanding during the period less the weighted-average number of restricted stock shares subject to repurchase.

We compute net income per diluted share using the sum of the weighted-average number of common and common-equivalent shares outstanding. Common-equivalent shares used in the computation of net income per diluted share include shares that may be issued under our stock option and restricted stock awards, our 2.00% Convertible Senior Notes due February 15, 2012 (2012 Notes), our 2.875% Convertible Senior Notes due February 15, 2015 (February 2015 Notes), and our 2.75% Convertible Subordinated Notes due August 16, 2023 (2023 Notes), on a weighted average basis for the period that the notes were outstanding, including the effect of adding back interest expense and the underlying shares using the if-converted method. The 2023 Notes were fully retired or converted as of September 14, 2010. The 2012 Notes were fully retired as of June 30, 2011.

The computation for net income per basic and diluted share was:

Three Months Ended

Nine Months Ended

September 30,

September 30,

(In thousands)

2011

2010

2011

2010

Numerator

Net income

$

45,916

$

40,189

$

160,447

$

116,334

Add back interest expense for implied conversion of convertible notes, net of estimated tax of $0.5 million for each of the three months ended September 30, 2011 and 2010, respectively, and $1.8 million and $2.1 million for the nine months ended September 30, 2011 and 2010, respectively (see Note 9)

841

987

3,391

3,982

Income used to compute net income per diluted share

$

46,757

$

41,176

$

163,838

$

120,316

Denominator

Total weighted-average shares used to compute net income per basic share

139,680

127,479

139,665

122,209

Effect of dilutive stock options

13

10

13

9

Restricted stock outstanding

12

106

21

99

Assumed conversion of 2012 Notes

-

32,050

19,743

32,050

Assumed conversion of February 2015 Notes

27,314

-

27,314

-

Assumed conversion of 2023 Notes

-

12,572

-

24,081

Shares used to compute income per diluted share

167,019

172,217

186,756

178,448

Net income per basic share

$

0.33

$

0.32

$

1.15

$

0.95

Net income per diluted share

$

0.28

$

0.24

$

0.88

$

0.67

We have excluded 0.2 million of outstanding stock options from our net income per diluted share calculations for the three months ended September 30, 2011, and 2010, respectively, and we have excluded 0.2 million and 0.4 million of outstanding stock options from our net income per diluted share for the nine months ended September 30, 2011, and 2010, respectively, because the option exercise prices were greater than the average market prices of our common stock during these periods; therefore, the shares were not dilutive.

In May 2011, we issued 3.75% Senior Convertible Notes due May 1, 2015 (May 2015 Notes). If converted, the principal amount of the May 2015 Notes will be settled in cash and the excess of the conversion value over the principal amount will be settled with shares of the Company’s common stock. For the periods presented, no stock was issuable upon conversion; therefore, the May 2015 Notes have been excluded for purposes of computing net income per diluted share.

Concurrent with the issuance of the May 2015 Notes, the Company entered into privately negotiated purchased call option transactions. The purchased call option transactions cover, subject to customary anti-dilution adjustments, the number of shares of the Company’s common stock that underlie the May 2015 Notes and are intended to reduce the dilutive impact of the conversion feature of the May 2015 Notes. Purchased call options are anti-dilutive and have been excluded from the determination of net income per diluted share.

To reduce the hedging costs of the purchased call options, the Company also entered into privately negotiated warrant transactions. The warrant transactions could have a dilutive effect to the extent that the market price per share of the Company’s common stock exceeds the applicable strike price of the warrants on any expiration date of the warrants. For the periods shown above, the strike price on the warrants exceeded the market price of the warrants and, accordingly, the warrants have been excluded from the determination of net income per diluted share.

3. Fair Value Measurements

The fair value of our financial instruments are estimates of the amounts that would be received if we were to sell an asset or we paid to transfer a liability in an orderly transaction between market participants at the measurement date or exit price. The assets and liabilities are categorized and disclosed in one of the following three categories:

Level 1 – based on quoted market prices in active markets for identical assets and liabilities;

Level 2 – based on quoted market prices for similar assets and liabilities, using observable market based inputs or unobservable market based inputs corroborated by market data; and

Level 3 – based on unobservable inputs using management’s best estimate and assumptions when inputs are unavailable. As of September 30, 2011, and December 31, 2010, we had no Level 3 assets or liabilities.

The following table summarizes assets and liabilities recorded at fair value by classification category:

September 30, 2011

December 31, 2010

(In thousands)

Level 1

Level 2

Total

Level 1

Level 2

Total

Assets:

Money market funds

$

151,497

$

-

$

151,497

$

203,318

$

-

$

203,318

Corporate debt securities

49,523

-

49,523

20,434

-

20,434

Commercial paper

-

6,943

6,943

-

7,998

7,998

U.S. government sponsored agency bonds

6,223

-

6,223

8,725

-

8,725

U.S. treasury securities

5,514

-

5,514

1,997

-

1,997

Foreign currency hedge contracts

-

11,174

11,174

-

17,763

17,763

Total

$

212,757

$

18,117

$

230,874

$

234,474

$

25,761

$

260,235

Liabilities:

Foreign currency hedge contracts

$

-

$

13,883

$

13,883

$

-

$

12,810

$

12,810

The fair value of commercial paper is estimated based on observable inputs of comparable securities.

The fair value of the foreign currency hedging contracts is estimated based on pricing models using readily observable inputs from actively quoted markets and are disclosed on a gross basis.

We do not estimate the fair value of our royalty assets for financial statement reporting purposes.

Our investments are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses, net of estimated taxes, reported in accumulated other comprehensive income (loss) in stockholders’ deficit. See Note 3 for fair value measurement information. The cost of securities sold is based on the specific identification method. To date, we have not experienced credit losses on investments in these instruments and we do not require collateral for our investment activities.

A summary of our available-for-sale securities is presented below:

Gross

Gross

Estimated

Amortized

Unrealized

Unrealized

Fair

September 30, 2011:

Cost

Gains

Losses

Value

(In thousands)

Money market funds

$

151,497

$

-

$

-

$

151,497

Corporate debt securities

49,573

27

(77

)

49,523

Commercial paper

6,944

-

(1

)

6,943

U.S. government sponsored agency bonds

6,209

14

-

6,223

U.S. treasury securities

5,493

21

-

5,514

Total

$

219,716

$

62

$

(78

)

$

219,700

December 31, 2010:

(In thousands)

Money market funds

$

203,318

$

-

$

-

$

203,318

Corporate debt securities

20,437

2

(5

)

20,434

Commercial paper

7,998

-

-

7,998

U.S. government sponsored agency bonds

8,727

-

(2

)

8,725

U.S. treasury securities

1,994

3

-

1,997

Total

$

242,474

$

5

$

(7

)

$

242,472

September 30,

December 31,

Classification on Consolidated Balance Sheets:

2011

2010

(In thousands)

Cash equivalents

$

151,497

$

205,817

Short-term investments

37,847

34,658

Long-term investments

30,356

1,997

Total

$

219,700

$

242,472

Available-for-sale debt securities by contractual maturity:

September 30, 2011

December 31, 2010

(In thousands)

Amortized

Fair

Amortized

Fair

Cost

Value

Cost

Value

Less than one year

$

37,852

$

37,847

$

37,162

$

37,157

Greater than one year but less than five years

30,367

30,356

1,994

1,997

Total

$

68,219

$

68,203

$

39,156

$

39,154

During the nine months ended September 30, 2011, and the year ended December 31, 2010, we did not recognize any gains or losses on sales of available-for-sale securities.

No significant facts or circumstances have arisen to indicate that there has been any deterioration in the creditworthiness of the issuers of these securities. Based on our review of these securities, we believe we had no other-than-temporary impairments on these securities as of September 30, 2011, because it is more likely than not that we will hold these securities until the recovery of their amortized cost basis.

Our licensees operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations between the U.S. dollar and other currencies, primarily the Eurodollar. In order to manage the risk related to changes in foreign currency exchange rates, we entered into a series of Eurodollar contracts in 2010 covering the quarters in which our licensees’ sales occur through December 2012. Our Eurodollar contracts used to hedge royalty revenues which are based on underlying Eurodollar sales are designated as cash flow hedges.

The following table summarizes the notional amounts, Eurodollar exchange rates and fair values of our open Eurodollar contracts designated as cash flow hedges:

September 30, 2011

December 31, 2010

Eurodollar Forward Contracts

(in thousands)

(in thousands)

Currency

Settlement Price

($ per Eurodollar)

Type

Notional Amount

Fair Value

Notional Amount

Fair Value

Eurodollar

1.400

Sell Eurodollar

$

50,205

$

1,838

$

137,179

$

6,740

Eurodollar

1.200

Sell Eurodollar

117,941

(13,883

)

117,941

(12,810

)

Total

$

168,146

$

(12,045

)

$

255,120

$

(6,070

)

Eurodollar Option Contracts

Currency

Strike Price

($ per Eurodollar)

Type

Notional Amount

Fair Value

Notional Amount

Fair Value

Eurodollar

1.510

Purchased call option

$

54,150

$

46

$

147,957

$

772

Eurodollar

1.315

Purchased call option

129,244

9,290

129,244

10,251

Total

$

183,394

$

9,336

$

277,201

$

11,023

The following table summarizes information about the fair value of our Eurodollar contracts on our Condensed Consolidated Balance Sheets:

Fair Value (In thousands)

Cash Flow Hedge

Location

September 30, 2011

December 31, 2010

Eurodollar contracts, net

Prepaid and other current assets

$

797

$

5,946

Eurodollar contracts, net

Accrued liabilities

1,993

-

Eurodollar contracts, net

Other long-term liabilities

1,513

993

Eurodollar contracts are presented on a net basis on our Condensed Consolidated Balance Sheets as we have entered into a netting arrangement with the counterparty. As of September 30, 2011, the unrealized net loss on the effective component of our Eurodollar contracts included in other comprehensive income (loss), net of estimated taxes, was $1.8 million. As of December 31, 2010, the unrealized net gain on the effective component of our Eurodollar contracts included in other comprehensive income (loss), net of estimated taxes, was $3.2 million.

We recognized a $0.7 million loss in royalty revenue due to settled Eurodollar contracts for the three months ended September 30, 2011. We recognized a $0.2 million gain in royalty revenue due to settled Eurodollar contracts for the nine months ended September 30, 2011. For the three and nine months ended September 30, 2010, we recognized gains of $2.9 million and $4.5 million, respectively, in royalty revenue due to settled Eurodollar contracts. Approximately $0.8 million in revenue is expected to be reclassified from other comprehensive income (loss) into earnings in the next 12 months.

Convertible and non-recourse notes activity for the nine months ended September 30, 2011, and fair values at September 30, 2011:

(In thousands)

2012

Notes

February

2015 Notes

May 2015

Notes

Non-recourse

Notes

Total

Balance at December 31, 2010

$

133,464

$

176,964

$

-

$

204,270

$

514,698

Issuance

-

-

136,313

-

136,313

Payment

-

-

-

(89,002

)

(89,002

)

Redemption

(133,464

)

-

-

-

(133,464

)

Discount amortization

-

521

1,570

-

2,091

Balance at September 30, 2011

$

-

$

177,485

$

137,883

$

115,268

$

430,636

Fair value
(1)

$

-

$

178,650

$

146,420

$

117,573

$

442,643

(1)

As of September 30, 2011, the fair value of the remaining payments under our Convertible notes and Non-recourse Notes was estimated based on the trading value of our notes then outstanding.

PDL was in compliance with all applicable debt covenants at September 30, 2011. Embedded features of all debt agreements were evaluated and did not need to be accounted for separately at September 30, 2011.

On May 16, 2011, we issued $155.3 million in aggregate principal amount, at par, of the May 2015 Notes in an underwritten public offering, for net proceeds of $149.7 million. The May 2015 Notes are due May 1, 2015, and are convertible into 132.6682 shares of the Company’s common stock per $1,000 of principal amount, or approximately $7.54 per share, subject to further adjustment upon certain events including dividend payments. We pay interest at 3.75% on the May 2015 Notes semiannually in arrears on May 1 and November 1 of each year, beginning November 1, 2011. Proceeds from the May 2015 Notes, net of amounts used for purchased call option transactions and funds provided by the warrant transactions described below, were used to redeem the 2012 Notes. Upon the occurrence of a fundamental change, as defined in the indenture, holders have the option to require PDL to repurchase their May 2015 Notes at a purchase price equal to 100% of the principal, plus accrued interest.

The May 2015 Notes are convertible under any of the following circumstances:

·

During any fiscal quarter ending after the quarter ending June 30, 2011, if the last reported sale price of our common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 130% of the conversion price for the notes on the last day of such preceding fiscal quarter;

·

During the five business-day period immediately after any five consecutive trading-day period, which we refer to as the measurement period, in which the trading price per $1,000 principal amount of notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the notes for each such day; or

·

Upon the occurrence of specified corporate events as described further in the indenture at any time on or after November 1, 2014.

If a conversion occurs, to the extent that the conversion value exceeds the principal amount, the principal amount is due in cash and the difference between the conversion value and the principal amount is due in shares of the Company’s common stock. As of September 30, 2011, the if-converted amount of the May 2015 Notes was less than the principal amount.

In accordance with the accounting guidance for convertible debt instruments that may be settled in cash or other assets on conversion, we were required to separately account for the liability component of the instrument in a manner that reflects the market interest rate for a similar nonconvertible instrument at the date of issuance. As a result, we separated the principal balance of the May 2015 Notes between the fair value of the debt component and the fair value of the common stock conversion feature. Using an assumed borrowing rate of 7.5%, which represents the estimated market interest rate for a similar nonconvertible instrument available to us on the date of issuance, we recorded a total debt discount of $18.9 million, allocated $12.3 million to additional paid-in capital and $6.6 million to deferred tax liability. The discount is being amortized to interest expense over the term of the May 2015 Notes and increases interest expense during the term of the May 2015 Notes from the 3.75% cash coupon interest rate to an effective interest rate of 7.5%. The fair value of the common stock conversion feature of $12.3 million is recorded as a component of stockholders’ deficit. As of September 30, 2011, the remaining discount amortization period is 3.6 years.

The carrying value and unamortized discount of the May 2015 Notes were:

(In thousands)

September 30, 2011

Principal amount of the May 2015 Notes

$

155,250

Unamortized discount of liability component

(17,367

)

Net carrying value of the May 2015 Notes

$

137,883

Interest expense for the May 2015 Notes included in Interest and other expense, net on the Condensed Consolidated Statements of Income was:

In connection with the issuance of the May 2015 Notes, we entered into purchased call option transactions with two hedge counterparties entitling the Company to initially purchase up to 19.6 million shares of the Company’s common stock. In addition, we sold to the hedge counterparties warrants exercisable, on a cashless basis, for up to 27.5 million shares of the Company’s common stock. The purchased call option transactions and warrant sales effectively serve to reduce the potential dilution associated with conversion of the May 2015 Notes. The strike prices at September 30, 2011, were approximately $7.54 and $8.87, subject to further adjustment upon certain events including dividend payments, for the purchased call options and warrants, respectively.

If the share price is above $7.54, upon conversion of the May 2015 Notes, the purchased call options will offset the share dilution, because the Company will receive shares on exercise of the purchased call options equal to the shares that the Company must deliver to the note holders. If the share price is above $8.87, upon exercise of the warrants, the Company will deliver shares to the counterparties in an amount equal to the excess of the share price over $8.87. For example, a 10% increase in the share price above $8.87 would result in the issuance of 1.9 million incremental shares upon exercise of the warrants. As our share price continues to increase, additional dilution would occur.

While the purchased call options are expected to reduce the potential equity dilution upon conversion of the May 2015 Notes, prior to conversion or exercise, the May 2015 Notes and the warrants could have a dilutive effect on the Company’s earnings per share to the extent that the price of the Company’s common stock during a given measurement period exceeds the respective exercise prices of those instruments.

The purchased call options and warrants are considered indexed to PDL stock, require net-share settlement, and met all criteria for equity classification at inception and at September 30, 2011. The purchased call options cost of $20.7 million, net of deferred taxes of $7.2 million, and $10.9 million received for the warrants were recorded as adjustments to additional paid-in capital. Subsequent changes in fair value will not be recognized as long as the purchased call options and warrants continue to meet the criteria for equity classification.

Purchased Call Options

We paid an aggregate amount of $20.7 million to two hedge counterparties for the purchased call options with terms substantially similar to the embedded conversion options in the May 2015 Notes. The purchased call options cover, subject to anti-dilution and certain other customary adjustments substantially similar to those in the May 2015 Notes, approximately 20.6 million shares of our common stock at a strike price of approximately $7.54, which corresponds to the conversion price of the May 2015 Notes. We may exercise the purchased call options upon conversion of the May 2015 Notes and require the hedge counterparty to deliver shares to the Company in an amount equal to the shares required to be delivered by the Company to the note holder for the excess conversion value. The purchased call options expire on May 1, 2015, or the last day any of the May 2015 Notes remain outstanding.

Warrants

We received an aggregate amount of $10.9 million from the two hedge counterparties for the sale of rights to receive up to 27.5 million shares of common stock underlying the May 2015 Notes, at a current strike price of approximately $8.87 per share, subject to additional anti-dilution and certain other customary adjustments.
The warrant counterparties may exercise the warrants on their specified expiration dates that occur over a period of time ending on January 20, 2016. If the volume weighted average share price of our common stock, as defined in the warrants (VWAP), exceeds the strike price of the warrants, we will deliver to the warrant counterparties shares equal to the spread between the VWAP on the date of exercise or expiration and the strike price. If the VWAP is less than the strike price, neither party is obligated to deliver anything to the other.

2012 Notes

On June 30, 2011, we redeemed the $133.5 million in aggregate principal outstanding of 2012 Notes, at a redemption price of 100.29% of face value for aggregate consideration of $133.9 million plus interest of $1.0 million. With the completion of this redemption on June 30, 2011, the 2012 Notes were fully retired.

In August 2010, we received a letter from Genentech, sent on behalf of F. Hoffman-La Roche Ltd. (Roche) and Novartis AG (Novartis), indicating that they believe that sales of their products that are both manufactured and sold outside of the United States do not infringe our supplementary protection certificates (SPCs) granted to us by various countries in Europe. Our SPCs generally extend the patent protection for our European Patent No. 0 451 216B (‘216B Patent) until December 2014, except that the SPCs for Herceptin will generally expire in July 2014. In response, we filed a complaint against Genentech, Roche and Novartis in Nevada, as we believe that a settlement agreement reached in 2003 between Genentech and us resolved all patent disputes between the two companies at that time. The matter is still ongoing with Genentech and Roche; however, we reached a settlement agreement with Novartis in early 2011.

On July 7, 2011, the Second Judicial District Court of Nevada denied motions made by Genentech and Roche to dismiss four of PDL’s claims for relief relating to the 2003 settlement agreement with Genentech and, further, denied Roche’s motion to dismiss for lack of personal jurisdiction. The court dismissed one of PDL’s claims that Genentech committed a bad-faith breach of the covenant of good faith and fair dealing with regard to the 2003 settlement agreement stating that, on the current state of pleadings, no “special relationship” had been established between Genentech and PDL, as required under Nevada law.

The effect of the Court’s ruling is that PDL is permitted to continue to pursue its claims that (i) Genentech is obligated to pay royalties to PDL on international sales of the Genentech Products; (ii) Genentech, by challenging, at the behest of Roche and Novartis, whether PDL’s SPCs cover the Genentech Products, breached its contractual obligations to PDL under the 2003 settlement agreement; (iii) Genentech breached the implied covenant of good faith and fair dealing with respect to the 2003 settlement agreement and (iv) Roche intentionally and knowingly interfered with PDL’s contractual relationship with Genentech in conscious disregard of PDL’s rights.

PDL seeks compensatory damages, including liquidated damages and other monetary remedies set forth in the 2003 settlement agreement, punitive damages and attorney’s fees as a result of Genentech and Roche’s conduct. The ultimate outcome of this litigation is uncertain and we may not be successful in our allegations.

Novartis Settlement

In February 2011, we reached a settlement with Novartis under which we agreed to dismiss our claims against Novartis in the action in Nevada state court, which also includes Genentech and Roche as defendants, and Novartis agreed to withdraw its opposition appeal in the European Patent Office challenging the validity of the ‘216B Patent. Under the settlement agreement with Novartis, after receipt of our royalty payment for sales of Lucentis each quarter, we pay Novartis a portion of the royalties that we receive for Lucentis sales made by them.

Lease Guarantee

In connection with the divestiture of our former biotechnology subsidiary, Facet Biotech Corporation (Facet), we entered into amendments to the leases for our former facilities in Redwood City, California, under which Facet was added as a co-tenant, and a Co-Tenancy Agreement, under which Facet agreed to indemnify us for all matters related to the leases attributable to the period after the divestiture. Should Facet default under the lease obligations, we would be held liable by the landlord as a co-tenant and, thus, we have in substance guaranteed the payments under the lease agreements for the Redwood City facilities. As of September 30, 2011, the total lease payments for the duration of the guarantee, which runs through December 2021, were approximately $113.4 million. We would also be responsible for lease related costs including utilities, property taxes and common area maintenance which may be as much as the actual lease payments if Facet defaulted. In April 2010, Abbott Laboratories acquired Facet and later renamed the company Abbott Biotherapeutics Corp. We recorded a liability of $10.7 million on our Condensed Consolidated Balance Sheets as of September 30, 2011, and December 31, 2010, related to the estimated fair value of this guarantee.

Stock-based compensation expense for the three and nine months ended September 30, 2011, and 2010, was:

Three Months Ended

Nine Months Ended

September 30,

September 30,

(In thousands)

2011

2010

2011

2010

General and administrative expenses

$

132

$

166

$

256

$

525

Income tax effect

(46

)

(58

)

(90

)

(184

)

Stock-based compensation expense included in net income

$

86

$

108

$

166

$

341

During the three months ended September 30, 2011, the Company awarded a grant of 20,000 shares of restricted stock, subject to vesting conditions, to a consultant. During the nine months ended September 30, 2011, the Company awarded approximately 135,000 shares of restricted stock, subject to vesting conditions, to directors, employees and a consultant.

During the nine months ended September 30, 2010, the Company awarded approximately 40,000 shares of restricted stock, subject to vesting conditions, to directors. Additionally, approximately 1.3 million fully vested stock options with an average exercise price of $20.36 per share were forfeited and expired unexercised.

13. Cash Dividends

On February 25, 2011, our board of directors declared a regular quarterly dividend of $0.15 per share of common stock, payable March 15, June 15, September 15 and December 15 of 2011 to stockholders of record on March 8, June 8, September 8 and December 8 of 2011, the record dates of each of the dividend payment dates, respectively. We paid $21.0 million to our stockholders on each of March 15, June 15, and September 15, 2011, using current year earnings and cash on hand. As of September 30, 2011, we have accrued $21.0 million in dividends payable for the December 15, 2011, dividend.

In connection with the payment of the dividend on September 15, 2011, the conversion ratios for our convertible notes increased. The conversion ratio for the February 2015 Notes was adjusted to 151.713 shares per $1,000 principal amount, or approximately $6.59 per share, effective September 9, 2011. The conversion ratio for our May 2015 Notes was adjusted to 132.6682 shares per $1,000 principal amount, or approximately $7.54 per share, effective September 6, 2011.

Income tax expense was $25.0 million and $87.0 million for the three months and nine months ended September 30, 2011, respectively, and was primarily determined by applying the federal statutory rate of 35% to Income before income taxes. Income tax expense was $23.0 million and $70.8 million for the three and nine months ended September 30, 2010, respectively, and was primarily determined by applying the federal statutory income tax rate of 35% to Income before income taxes, adjusted for a portion of the premium paid for the repurchase of our 2023 Notes that was not tax deductible.

This Quarterly Report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts are “forward-looking statements” for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, including any statements concerning new licensing, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “intends,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue” or “opportunity,” or the negative thereof or other comparable terminology. Although we believe that the expectations presented in the forward-looking statements contained herein are reasonable at the time they were made, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below or incorporated by reference herein, and for the reasons described elsewhere in this Quarterly Report. All forward-looking statements and reasons why results may differ included in this Quarterly Report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.

OVERVIEW

PDL pioneered the humanization of monoclonal antibodies and, by doing so, enabled the discovery of a new generation of targeted treatments for cancer and immunologic diseases. Today, PDL is focused on intellectual property asset management, investing in new royalty bearing assets and maximizing the value of its patent portfolio and related assets. We receive royalties based on sales of humanized antibody products marketed today and may also receive royalty payments on additional humanized antibody products launched before final patent expiry in December 2014. Under most of our licensing agreements, we are entitled to receive a flat-rate or tiered royalty based upon our licensees’ net sales of covered antibodies.

We continuously evaluate alternatives to increase return for our stockholders, for example, purchasing new royalty generating assets, buying back or redeeming our convertible notes, repurchasing our common stock, selling the company and paying dividends. At the beginning of each fiscal year, our board of directors reviews the Company’s total annual dividend payment for the prior year and determines whether to increase, maintain or decrease the quarterly dividend payments for that year. The board of directors evaluates the financial condition of the Company and considers the economic outlook, corporate cash flow, the Company’s liquidity needs and the health and stability of credit markets when determining whether to maintain or change the dividend.

Recent Developments

Dividend Payment

On February 25, 2011, our board of directors declared a regular quarterly dividend of $0.15 per share of common stock, payable March 15, June 15, September 15 and December 15 of 2011 to stockholders of record on March 8, June 8, September 8 and December 8 of 2011, the record dates of each of the dividend payment dates, respectively. We paid $21.0 million to our stockholders on each of March 15, June 15, and September 15, 2011, using current year earnings and cash on hand. As of September 30, 2011, we have accrued $21.0 million in dividends payable for the December 15, 2011, dividend.

Adjustments to Convertible Note Conversion Ratios

In connection with the September 15, 2011, dividend payment, the conversion ratios for our convertible notes increased. The conversion ratio for our 2.875% Convertible Senior Notes due February 15, 2015 (February 2015 Notes), was adjusted to 151.713 shares of common stock per $1,000 principal amount, or approximately $6.59 per share, effective September 9, 2011. The conversion ratio for our 3.75% Convertible Senior Notes due May 1, 2015 (May 2015 Notes), was adjusted to 132.6682 shares of common stock per $1,000 principal amount, or approximately $7.54 per share, effective September 6, 2011. The conversion ratio for the February 2015 Notes was previously 147.887 shares of common stock per $1,000 principal amount, or a conversion price of approximately $6.76 per share. The conversion ratio for the May 2015 Notes was previously 129.2740 shares of common stock per $1,000 principal amount, or a conversion price of approximately $7.74 per share.

In connection with a cash dividend, the conversion ratio for the February 2015 Notes increases by multiplying the previous conversion ratio by a fraction, the numerator of which is the average closing price of PDL's common stock for the five consecutive trading days immediately preceding the ex-dividend date for the cash dividend and the denominator of which is the difference of such average closing price less the dividend amount. For the May 2015 Notes, the numerator equals the average closing price of PDL's common stock for the ten consecutive trading days immediately preceding the ex-dividend date and the denominator is the difference of such ten day average closing price less the dividend amount.

In August 2010, we received a letter from Genentech, Inc. (Genentech), sent on behalf of F. Hoffman-La Roche Ltd. (Roche) and Novartis AG (Novartis), asserting that Avastin
®
, Herceptin
®
, Lucentis
®
and Xolair
®
(the Genentech Products) do not infringe our supplementary protection certificates (SPCs) granted to us by various countries in Europe for each of the Genentech Products and seeking a response to these assertions. The SPCs covering the Genentech Products effectively extend the patent protection for our European Patent No. 0 451 216B (the ‘216B Patent) until December 2014, except that the SPCs for Herceptin will generally expire in July 2014. We responded to Genentech, stating that we believe its assertions of non-infringement are without merit and that we disagreed fundamentally with its assertions of non-infringement with respect to the Genentech Products. In August 2010, we filed a complaint in the Second Judicial District of Nevada, Washoe County, against Genentech and Roche, seeking to enforce our rights under our 2003 settlement agreement with Genentech and an order from the court declaring that Genentech is obligated to pay royalties to us on sales of the Genentech Products that are manufactured and sold outside of the United States.

On July 7, 2011, the Second Judicial District Court of Nevada ruled in favor of PDL on two motions to dismiss filed by Genentech and Roche in PDL’s lawsuit related to the 2003 settlement agreement with Genentech. The court denied Genentech and Roche’s motion to dismiss four of PDL’s five claims for relief and, further, denied Roche’s separate motion to dismiss for lack of personal jurisdiction. The court dismissed one of PDL’s claims that Genentech committed a bad-faith breach of the covenant of good faith and fair dealing stating that, based on the current state of the pleadings, no “special relationship” had been established between Genentech and PDL, as required under Nevada law.

The effect of the Court’s ruling is that PDL is permitted to continue to pursue its claims that (i) Genentech is obligated to pay royalties to PDL on international sales of the Genentech Products; (ii) Genentech, by challenging, at the behest of Roche and Novartis, whether PDL’s SPCs cover the Genentech Products, breached its contractual obligations to PDL under the 2003 settlement agreement; (iii) Genentech breached the implied covenant of good faith and fair dealing with respect to the 2003 settlement agreement and (iv) Roche intentionally and knowingly interfered with PDL’s contractual relationship with Genentech in conscious disregard of PDL’s rights.

PDL seeks compensatory damages, including liquidated damages and other monetary remedies set forth in the 2003 settlement agreement, punitive damages and attorney’s fees as a result of Genentech and Roche’s conduct. The ultimate outcome of this litigation is uncertain and we may not be successful in our allegations.

Patents and Technology Out-License Agreements

Patents

We have been issued patents in the United States and elsewhere, covering the humanization of antibodies, which we refer to as our Queen et al. patents. Our Queen et al. patents, for which final patent expiry is in December 2014, cover, among other things, humanized antibodies, methods for humanizing antibodies, polynucleotide encoding in humanized antibodies and methods of producing humanized antibodies.

The following is a list of our U.S. patents within our Queen et al. patent portfolio:

Application Number

Filing Date

Patent Number

Issue Date

08/477,728

06/07/95

5,585,089

12/17/96

08/474,040

06/07/95

5,693,761

12/02/97

08/487,200

06/07/95

5,693,762

12/02/97

08/484,537

06/07/95

6,180,370

01/30/01

The '216B Patent expired in Europe in December 2009. We have been granted SPCs for the Avastin, Herceptin, Lucentis, Xolair and Tysabri
®
products in many of the jurisdictions in the European Union in connection with the ‘216B Patent. These SPCs effectively extend our patent protection with respect to these products generally until December 2014, except that the SPCs for Herceptin will generally expire in July 2014. Because SPCs are granted on a jurisdiction-by-jurisdiction basis, the duration of the extension varies slightly in some jurisdictions. We are not able to file applications for any new SPCs after the ‘216B Patent expiration. Therefore, if a product is first approved for marketing after December 2009 in a jurisdiction that issues SPCs, we will not have patent protection or SPC protection in that jurisdiction with respect to this product. We may still be eligible for royalties notwithstanding the unavailability of SPC protection if the relevant royalty-bearing humanized antibody product is also made, used, sold or offered for sale in or imported from a jurisdiction in which we have an unexpired Queen et al. patent, such as the United States.

We have entered into licensing agreements with numerous entities that are independently developing or have developed humanized antibodies pursuant to which we have licensed certain rights under our Queen et al. patents to make, use, sell, offer for sale and import humanized antibodies. We receive royalties on net sales of products that are made, used or sold prior to patent expiry. In general, these agreements cover antibodies targeting antigens specified in the license agreements. Under our licensing agreements, we are entitled to receive a flat-rate or tiered royalty based upon our licensees’ net sales of covered antibodies. Our licensing agreements generally entitle us to royalties following the expiration of our patents with respect to sales of products manufactured prior to patent expiry in a jurisdiction providing patent protection. We also expect to receive minimal annual maintenance fees from licensees of our Queen et al. patents prior to patent expiry as well as periodic milestone payments. Total annual milestone payments in each of the last several years have been less than 1% of total revenue and we expect this trend will continue through the expiration of the Queen et al. patents.

Licensing Agreements for Marketed Products

In the nine months ended September 30, 2011, we received royalties on sales of the seven humanized antibody products listed below, all of which are currently approved for use by the U.S. Food and Drug Administration (FDA) and other regulatory agencies outside the United States.

For the three months ended September 30, 2011, and 2010, we received royalty revenues under license agreements of $83.4 million and $86.4 million, respectively. For the nine months ended September 30, 2011, and 2010, we received royalty revenues under license agreements of $278.8 million and $268.8 million, respectively. The licensees with commercial products as of September 30, 2011, are listed below:

Licensee

Product Names

Genentech, Inc. (Genentech)

Avastin
®

Herceptin
®

Xolair
®

Lucentis
®

Elan Corporation, Plc (Elan)

Tysabri
®

Wyeth Pharmaceuticals, Inc. (Wyeth)

Mylotarg
®

Chugai Pharmaceutical Co., Ltd. (Chugai)

Actemra
®

In June 2010, after results from a recent clinical trial raised concerns about the efficacy and safety of Mylotarg, Pfizer Inc. (Pfizer), the parent company of Wyeth, announced that it will be discontinuing commercial availability of Mylotarg. We received royalties related to Mylotarg
sales of $0.1 million and $0.3 million for the three months ended September 30, 2011, and 2010, respectively, and $0.2 million and $0.8 million for the nine months ended September 30, 2011, and 2010, respectively.

Genentech

We entered into a master patent license agreement, effective September 25, 1998, pursuant to which we granted Genentech a license under our Queen et al. patents to make, use and sell certain antibody products. Our master patent license agreement with Genentech provides for a tiered royalty structure under which the royalty rate Genentech must pay on royalty-bearing products sold in the United States or manufactured in the United States and used or sold anywhere in the world (U.S.-based Sales) in a given calendar year decreases on incremental U.S.-based Sales above certain sales thresholds based on 95% of the underlying gross U.S.-based Sales. The net sales thresholds and the applicable royalty rates are outlined below:

Aggregate Net Sales

Royalty Rate

Net sales up to $1.5 billion

3.0

%

Net sales between $1.5 billion and $2.5 billion

2.5

%

Net sales between $2.5 billion and $4.0 billion

2.0

%

Net sales exceeding $4.0 billion

1.0

%

As a result of the tiered royalty structure, Genentech’s average annual royalty rate for a given year will decline as Genentech’s U.S.-based Sales increase during that year. Because we receive royalties one quarter in arrears, the average royalty rates for the payments we receive from Genentech for U.S.-based Sales in the second calendar quarter for Genentech’s sales from the first calendar quarter have been and are expected to continue to be higher than the average royalty rates for following quarters. The average royalty rates for payments we receive from Genentech are generally lowest in the fourth and first calendar quarters for Genentech’s sales from the third and fourth calendar quarters when more of Genentech’s U.S.-based Sales bear royalties at the 1% royalty rate.

With respect to royalty-bearing products that are both manufactured and sold outside of the United States (ex-U.S.-based Manufacturing and Sales), the royalty rate that we receive from Genentech is a fixed rate of 3.0% based on 95% of the underlying gross ex-U.S.-based Manufacturing and Sales. The mix of U.S.-based Sales and ex-U.S.-based Manufacturing and Sales has fluctuated in the past and may continue to fluctuate in future periods, particularly in light of the 2009 acquisition of Genentech by Roche. The percentage of total global sales that were generated outside of the United States and the percentage of total global sales that were ex-U.S.-based Manufacturing and Sales are outlined in the following table:

Three Months Ended

Nine Months Ended

September 30,

September 30,

2011

2010

2011

2010

Avastin

% Ex-U.S. Sold

56

%

49

%

56

%

49

%

% Ex-U.S. Manufactured and Sold

19

%

27

%

19

%

20

%

Herceptin

% Ex-U.S. Sold

73

%

68

%

72

%

70

%

% Ex-U.S. Manufactured and Sold

43

%

45

%

38

%

45

%

Lucentis

% Ex-U.S. Sold

60

%

56

%

58

%

57

%

% Ex-U.S. Manufactured and Sold

0

%

0

%

0

%

0

%

Xolair

% Ex-U.S. Sold

41

%

34

%

40

%

35

%

% Ex-U.S. Manufactured and Sold

41

%

34

%

40

%

35

%

The information in the table above is based on information provided to us by Genentech. We were not provided the reasons for the shifts in the manufacturing between U.S.-based Sales and ex-U.S.-based Manufacturing and Sales.

In the nine months ended September 30, 2011, PDL received royalties generated from three of Genentech’s licensed products which were both manufactured and sold outside of the United States: Herceptin, Avastin and Xolair. Prior to the first quarter of 2010, only Herceptin and Xolair generated royalties from ex-U.S.-based Manufacturing and Sales. Roche has announced that new plants in Singapore were registered by the FDA to produce bulk Avastin and Lucentis for use in the United States in 2010 and that they expect the plants to be registered to produce bulk Avastin and Lucentis for use in Europe in 2011. The master patent license agreement continues until the expiration of the last to expire of our Queen et al. patents but may be terminated (i) by Genentech prior to such expiration upon sixty days written notice, (ii) by either party upon a material breach by the other party or (iii) upon the occurrence of certain bankruptcy-related events.

Elan

We entered into a patent license agreement, effective April 24, 1998, pursuant to which we granted to Elan a license under our Queen et al. patents to make, use and sell antibodies that bind to the cellular adhesion molecule α4 in patients with multip
le sclerosis. Pursuant to the agreement, we are entitled to receive a flat royalty rate in the low single digits based on Elan’s net sales of the Tysabri product. The agreement continues until the expiration of the last to expire of our Queen et al. patents but may be terminated (i) by Elan prior to such expiration upon sixty days written notice, (ii) by either party upon a material breach by the other party or (iii) upon the occurrence of certain bankruptcy-related events.

Wyeth

We entered into a patent license agreement, effective September 1, 1999, pursuant to which we granted to Wyeth a license under our Queen et al. patents to make, use and sell antibodies that bind to CD33, an antigen that is found in about 80% of patients with acute myeloid leukemia, and conjugated to a cytotoxic agent. Pursuant to the agreement, we are entitled to receive a flat royalty rate in the low single digits based on Wyeth’s net sales of the Mylotarg product. The agreement continues until the expiration of the last to expire of our Queen et al. patents but may be terminated (i) by Wyeth prior to such expiration upon sixty days written notice, (ii) by either party upon a material breach by the other party or (iii) upon the occurrence of certain bankruptcy-related events. In June 2010, after results from a recent clinical trial raised concerns about the efficacy and safety of Mylotarg, Pfizer, the parent company of Wyeth, announced that it is discontinuing commercial availability of Mylotarg.

We entered into a patent license agreement, effective May 18, 2000, with Chugai, a majority owned subsidiary of Roche, pursuant to which we granted to Chugai a license under our Queen et al. patents to make, use and sell antibodies that bind to interleukin-6 receptors to prevent inflammatory cascades involving multiple cell types for the treatment of rheumatoid arthritis. Pursuant to the agreement, we are entitled to receive a flat royalty rate in the low single digits based on net sales of the Actemra product. The agreement continues until the expiration of the last to expire of our Queen et al. patents but may be terminated (i) by Chugai prior to such expiration upon sixty days written notice, (ii) by either party upon a material breach by the other party or (iii) upon the occurrence of certain bankruptcy-related events.

Licensing Agreements for Non-Marketed Products

We have also entered into licensing agreements pursuant to which we have licensed certain rights under our Queen et al. patents to make, use and sell certain products in development that have not yet reached commercialization. Certain of these development-stage products are currently in Phase 3 clinical trials. With respect to these agreements, we may receive payments based on certain development milestones and annual maintenance fees. We may also receive royalty payments if the licensed products receive marketing approval and are manufactured or generate sales before the expiration of our Queen et al. patents. For example, both Eli Lilly and Company (Lilly) and Wyeth have licensed antibodies for the treatment of Alzheimer’s disease that are currently in Phase 3 clinical trials. Another example is trastuzumab-DM1 (T-DM1) which is an experimental, antibody-drug conjugate that links Herceptin to a cytotoxic, or cell killing agent, DM1, being developed by Genentech. This approach is designed to increase the already significant tumor fighting ability of Herceptin by coupling it with an additional cell killing agent that is efficiently and simultaneously delivered to the targeted cancer cells by the antibody.

Economic and Industry-wide Factors

Various economic and industry-wide factors are relevant to us and could affect our business, including the factors set forth below.

·

Our business success is dependent in significant part on our success in maintaining and protecting our intellectual property rights. If we are unable to protect or defend our intellectual property, our royalty revenues and operating results would be adversely affected. Assertion and defense of our intellectual property rights can be expensive and could result in a significant reduction in the scope or invalidation of our intellectual property rights, which could adversely affect our results of operations.

·

The manufacture of drugs and antibodies for use as therapeutics in compliance with regulatory requirements is complex, time-consuming and expensive. If our licensees are unable to manufacture product or product candidates in accordance with FDA and European good manufacturing practices, they may not be able to obtain or retain regulatory approval for products licensed under our patents.

·

Our licensees are subject to stringent regulation with respect to product safety and efficacy by various international, federal, state and local authorities and may be unable to maintain regulatory approvals for currently licensed products or obtain regulatory approvals for new products. For example, safety and efficacy issues could also result in the failure to maintain regulatory approvals or decrease revenues. In June 2010, after results from a recent clinical trial raised concerns about the efficacy and safety of Mylotarg, Pfizer, the parent company of Wyeth, announced that it was discontinuing commercial availability of Mylotarg.

·

In March 2010, the Patient Protection and Affordable Care Act was signed into law along with the related Health Care and Education Reconciliation Act of 2010 (collectively, the Act). The Act represents a major overhaul of the healthcare system in the United States and also includes a number of provisions that may affect our licensees and our royalty revenues.

·

Approximately 50% of our licensees’ product sales are in currencies other than the U.S. dollar; as such, our revenue may fluctuate due to changes in foreign currency exchange rates and is subject to foreign currency exchange risk. Therefore, shifts in currencies can impact our short-term results as well as our long-term revenue and net income projections.

·

To be successful, we must attract, retain and integrate qualified personnel. Our business is managing our patents and royalties assets, which requires a small number of employees. If we cannot recruit and retain qualified personnel, results from our operations could be adversely impacted.

·

Our business success is also dependent on overall economic conditions. The global financial downturn could adversely affect product sales by our licensees.

See also the “Risk Factors” section of this quarterly report for additional information on economic and industry wide and other factors that may impact our business and results of operations.

During the nine months ended September 30, 2011, there were no changes made to our critical accounting policies and the use of estimates. For further information please refer to “Critical Accounting Policies and Uses of Estimates” included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2010.

Recently Issued Accounting Pronouncements

The Financial Accounting Standards Board recently issued accounting standard update (ASU) 2011-05, eliminating the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The update requires presentation for items of net income and other comprehensive income either in one continuous statement or in two separate, but consecutive, statements. This ASU also includes a new requirement to show reclassification adjustments from other comprehensive income to net income on the face of the statement. This guidance is required for our first quarter of 2012 with retrospective application required. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.

RESULTS OF OPERATIONS

Three and Nine months Ended September 30, 2011, and 2010

Revenues

Revenues consist of royalty revenues as well as license and other revenues. During the three and nine months ended September 30, 2011, and 2010, our royalty revenues consisted of royalties and maintenance fees earned on sales of products under license agreements for our Queen et al. patents.

Three Months Ended

September 30,

Change from

Nine Months Ended

September
30,

Change from

(Dollars in thousands)

2011

2010

Prior Year

2011

2010

Prior Year

Revenues

Royalties

$

83,370

$

86,442

-4

%

$

278,833

$

268,846

4

%

License and other

400

-

N/A

10,400

-

N/A

Total revenues

$

83,770

$

86,442

-3

%

$

289,233

$

268,846

8

%

Total revenue for the three months ended September 30, 2011, was $83.8 million as compared with $86.4 million for the same period in 2010. Total revenue for the nine months ended September 30, 2011, was $289.2 million as compared with $268.8 million for the same period in 2010. Included in the results for the three and nine months ended September 30, 2011, is a $0.4 million milestone payment received from Roche. Also included in results for the nine months ended September 30, 2011, is a $10.0 million settlement payment from UCB resolving all legal disputes between the two companies, including those relating to UCB’s pegylated humanized antibody fragment, Cimzia
®
, and PDL’s patents known as the Queen et al. patents. Revenue for the three months ended September 30, 2011, is net of the payment made pursuant to our February 2011 settlement agreement with Novartis, which is based on a portion of the royalties that the Company receives for Lucentis sales made by Novartis outside of the United States. A payment was also made in the three months ended June 30, 2011.

Royalty revenue for the three months ended September 30, 2011, was approximately $83.4 million, as compared with $86.4 million for the three months ending September 30, 2010, a 4% year-over-year decrease. The decrease in revenue is primarily driven by reduced royalties on second quarter 2011 sales of Avastin, partially offset by increased royalties on sales of Herceptin, Tysabri and Lucentis. The third quarter royalty payment received from Genentech included royalties generated on all worldwide sales. Sales of Avastin, Herceptin and Lucentis are subject to a tiered royalty rate for product that is made or sold in the United States and a flat royalty rate of 3% for product that is manufactured and sold outside of the United States.

·

Reported worldwide sales of Avastin decreased $13.6 million or 1% in the second quarter of 2011 when compared to the same period in 2010. Roche recently reported that sales in the United States declined 15%, negatively impacted by reimbursement uncertainty regarding the metastatic breast cancer indication. In Europe, sales were down 10% due to austerity measures and some decline in the metastatic breast indication. Roche reported 12% growth in the rest of the world. Also contributing to the decrease in royalty revenue, ex-U.S. manufactured and sold Avastin sales declined to 19% of total Avastin sales in the second quarter of 2011 from 27% in the second quarter of 2010.

·

Reported worldwide sales for Herceptin increased $342.0 million or 26% in the second quarter of 2011 when compared to the same period in 2010. Roche recently reported that sales growth is being driven by increased penetration in emerging markets, increased HER2 testing and continued uptake in HER2-postive gastric cancer. Ex-U.S. manufactured and sold Herceptin sales declined to 43% of total Herceptin sales in the second quarter of 2011 from 45% in the second quarter of 2010.

Reported worldwide sales for Lucentis increased $307.4 million or 41% in the second quarter of 2011 when compared to the same period in 2010. Lucentis is approved for the treatment of age-related macular degeneration (AMD) in the United States and Europe. Lucentis received approval for the treatment of macular edema following retinal vein occlusion (RVO) in June 2010 in the United States and in June 2011 in Europe. Lucentis received approval for the treatment of visual impairment due to diabetic macular edema in Europe in January 2011. Genentech and Novartis recently reported that sales growth is being driven by continued growth in the treatment of RVO in the United States and increased uptake in all indications in Europe. All sales of Lucentis were from inventory produced in the United States.

·

Reported worldwide sales for Tysabri increased $95.1 million or 32% in the second quarter of 2011 when compared to the same period in 2010. Biogen Idec recently announced that, at the end of June 2011, approximately 61,500 patients were on therapy worldwide, representing a 17% increase over the approximately 52,700 patients who were on therapy at the end of June 2010 and, that cumulatively, 88,100 patients have been treated with Tysabri in the post-marketing setting. Tysabri royalties are determined at a flat rate as a percent of sales regardless of location of manufacture or sale.

Royalty revenue for the nine months ended September 30, 2011, increased by 4% when compared to the same period of 2010. The growth was primarily driven by increased sales of Herceptin, Lucentis and Tysabri by our licensees for which we received royalties in the first nine months of 2011.

·

Reported sales of Herceptin increased $673.1 million or 17% when compared to the same period for the prior year. Ex-U.S. sales of Herceptin increased 21% when compared to the same period for the prior year and represented 72% of total global sales.

·

Reported sales of Lucentis increased $717.8 million or 33% when compared to the same period for the prior year. Ex-U.S. sales of Lucentis increased 36% when compared to the same period for the prior year and represented 58% of total global sales.

·

Reported sales of Tysabri increased $200.7 million or 23% when compared to the same period for the prior year. Both U.S. and ex-U.S. sales of Tysabri increased 23% each compared to the same period for the prior year.

The following table summarizes revenues from our licensees’ products which individually accounted for 10% or more of our total royalty revenue for the three and nine months ended September 30, 2011, and 2010:

Three Months Ended

Nine Months Ended

September 30,

September 30,

Licensee

Product Name

2011

2010

2011

2010

Genentech

Avastin

29

%

35

%

32

%

34

%

Herceptin

38

%

32

%

36

%

33

%

Lucentis

15

%

13

%

16

%

14

%

Elan

Tysabri

14

%

10

%

12

%

10

%

The sales information presented above is based on information provided by PDL’s licensees in their quarterly reports to the Company as well as from public disclosures made by PDL’s licensees.

Under most of the agreements for the license of rights under our Queen et al. patents, we receive a flat-rate royalty based upon our licensees’ net sales of covered products. Royalty payments are generally due one quarter in arrears, that is, generally in the second month of the quarter after the licensee has sold the royalty-bearing product. Our agreement with Genentech provides for a tiered royalty structure where Genentech’s royalty rates on U.S.-based Sales decreases at certain sales thresholds during a calendar year based on 95% of the underlying gross U.S.-based Sales. As a result of the tiered royalty structure, Genentech’s average annual royalty rate for a given year will decline as Genentech’s U.S.-based Sales increase during that year. Because we receive royalties in arrears, the average royalty rate for the payments we receive from Genentech in the second calendar quarter for Genentech’s sales from the first calendar quarter has been and is expected to continue to be higher than the average royalty rate for following quarters. The average royalty rate for payments we receive from Genentech are generally lowest in the fourth and first calendar quarters for Genentech’s sales from the third and fourth calendar quarters when more of Genentech’s U.S.-based Sales bear royalties at the lowest royalty rate of 1%.

With respect to the ex-U.S.-based Manufacturing and Sales, the royalty rate that we receive from Genentech is a fixed rate of 3% based on 95% of the underlying gross ex-U.S.-based Manufacturing and Sales. The mix of U.S.-based Sales and ex-U.S.-based Manufacturing and Sales has fluctuated in the past and may continue to fluctuate in future periods, particularly in light of the 2009 acquisition of Genentech by Roche.

General and Administrative Expenses

Three Months Ended

September 30,

Change from

Nine Months Ended

September 30,

Change from

(Dollars in thousands)

2011

2010

Prior Year

2011

201
0

Prior Year

General and administrative expenses

$

3,960

$

11,110

-64

%

$

13,516

$

29,340

-54

%

General and administrative expenses for the three months ended September 30, 2011, were $4.0 million as compared with $11.1 million for the same period in 2010. The decrease in general and administrative expenses was primarily driven by decreases in legal expense. General and administrative expenses for the nine months ended September 30, 2011, were $13.5 million as compared with $29.3 million for the same period in 2010. The decrease in general and administrative expenses was primarily driven by decreases in legal expense and other professional services expense. The decreases in legal expense are a result of termination of our legal dispute with MedImmune, the opposition to our ‘216B patent in the European Patent Office and the interference proceedings in the U.S. Patent and Trademark Office, all of which were concluded in the first quarter of 2011. The decrease in other professional services expense for the nine months ended September 30, 2011, results from a reduction in one-time special project costs. We currently have fewer than ten employees managing business development activities, our intellectual property and licensing operations and other corporate activities, as well as providing for certain essential reporting and management functions of a public company.

Individual components of general and administrative expenses comprise:

Three Months Ended

September 30,

Change from

Nine Months Ended

September 30,

Change from

(Dollars in thousands)

2011

2010

Prior Year

2011

2010

Prior Year

Compensation and benefits

$

1,045

$

965

8

%

$

2,958

$

2,962

0

%

Legal expense

1,263

8,660

-85

%

6,162

20,821

-70

%

Other professional services

810

535

51

%

2,001

2,618

-24

%

Insurance

176

185

-5

%

556

608

-9

%

Depreciation

14

14

0

%

43

76

-43

%

Stock-based compensation

132

166

-20

%

256

525

-51

%

Other

520

585

-11

%

1,540

1,730

-11

%

Total general and administrative expenses

$

3,960

$

11,110

-64

%

$

13,516

$

29,340

-54

%

Non-operating Expense, Net

Three Months Ended

September 30,

Nine Months Ended

September 30,

(Dollars in thousands)

2011

2010

2011

2010

Loss on retirement or conversion of convertible notes

$

-

$

(2,354

)

$

(766

)

$

(18,681

)

Interest and other income

130

167

463

337

Interest and other expense

(9,007

)

(9,928

)

(27,941

)

(34,015

)

Total non-operating expense, net

$

(8,877

)

$

(12,115

)

$

(28,244

)

$

(52,359

)

Non-operating expense, net, for the three months ended September 30, 2011, was $8.9 million as compared with $12.1 million for the same period in 2010. The reduction in interest expense is primarily attributable to repayment and reduction in principal of our QHP PhaRMA
SM
Senior Secured Notes due March 15, 2015 (Non-recourse Notes), for which the current principal balance at September 30, 2011, was $115.3 million as compared with $225.0 million at September 30, 2010.

Non-operating expense, net, for the nine months ended September 30, 2011, was $28.2 million as compared with $52.4 million for the same period in 2010. The loss on retirement or conversion of convertible notes comprises costs incurred to repurchase or convert our 2.75% Convertible Subordinated Notes due August 16, 2023 (2023 Notes). The reduction in interest expense is primarily attributable to repayment and reduction in principal of the Non-recourse Notes.

Income Taxes

Income tax expense was $25.0 million and $87.0 million for the three months and nine months ended September 30, 2011, respectively, and was primarily determined by applying the federal statutory rate of 35% of income before income taxes. Income tax expense was $23.0 million and $70.8 million for the three and nine months ended September 30, 2010, respectively, and was primarily determined by applying the federal statutory income tax rate of 35% to income before income taxes, adjusted for a portion of the premium paid for the repurchase of 2023 Notes that was not tax deductible.